No-fault Banking: Freedom Bails Out

When the Feds swept in recently to take over several savings and loan associations in the Chicago area, it was another example of how no-fault banking policy operates in this country.

You can engage in the worst sort of business practices and be assured that, in the end, the government will bail you out or see to it that you are taken over and sold, so that your creditors will be happy. And I am not just talking about S&Ls. I am speaking of commercial banks, too.

If you are large enough, of course, the government takes over the institution and sorts out the mess you have created. Then it will turn the institution over to another group of managers, just as it did with Continental Bank.

But does this lead to more responsible banking practices? I`m afraid not. It is instructive to see how financial institutions left and right are rushing out to finance leveraged buyouts, since that`s where the money is, while de-emphasizing more traditional forms of lending.

If you take away the element of risk from a business, you can be sure that banking executives will say hang the risk, full lending ahead. Since others are making money from junk bonds, why should they be denied the opportunity for a good return?

The S&L bailout, however, has changed the rules of the game. Now that the government has decided to rescue institutions en masse with taxpayers` money, there is simply no excuse anymore to permit irresponsible banking practices.

Let me be clear on what is at stake. Every loan decision, large and small, by a banker or savings and loan executive in the United States is now- and forevermore-a contingent liability on the U.S. Treasury, and potentially part of everyone`s tax bill.

What that means is that if the bank or S&L goes sour and there isn`t enough money in the federal insurance kitty to assume the risk, taxpayers will have to do so. Every financial institution in the nation is a potential ward of the state.

That was the key reason why the Council of Economic Advisers had the audacity recently to suggest that federal deposit insurance, which insures our deposits up to $100,000, be reduced sharply.

The council reasoned that if nearly all deposits are deemed safe, even those in the worst-managed institutions, then the system is unsafe. The financial buccaneers will pay outrageous interest rates to attract deposits, so they can make high-yielding but unsafe loans, in the firm belief that the government will make depositors whole, no matter what happens.

The trouble with the council`s suggestion is that most depositors have no practical way of checking the health of an institution in which they put their money. Our federal banking regulators, and our bankers, discourage depositors from obtaining this information. They would prefer that the dirty linen be kept in the closet. Let it be said that the chairman of the council who made that recommendation, the since-departed Beryl Sprinkel, himself comes from a banking background.

Since the Great Depression, the federal banking system has gone out of its way to prevent disclosure of troubled institutions, on grounds that this would undermine confidence in the entire system. No one wants a repeat of the bank runs of the 1930s, but the way the government is taking institutions over, that isn`t about to happen.

I don`t think bankers yet see the stakes involved in this situation. By continuing to keep their heads in the sand and pursuing irresponsible lending practices, they threaten the end of free banking in the United States.

Through their elected representatives, taxpayers, required to foot some or all the bill for fraudulent or stupid loans, will demand a piece of the action. If this looseness in banking persists, it is not inconceivable to expect legislation that would establish a federal loan approval agency, which would have the power to give the ultimate okay to all loans over a certain size.

That, indeed, would be a sad day for America, but I would not rule it out. The Bush administration, through that lightweight of a Treasury secretary, Nicholas Brady, would do well to consider the activism that his bailout plan will inspire in the political arena.

Only recently, that most conservative of men in America, Housing and Urban Development Secretary Jack Kemp, suggested that failed S&Ls be forced to put some of their money into the nation`s ghettoized inner cities.

Bankers should take this as a warning. If a right-wing leader like Kemp can suggest credit allocation, then moderates and liberals will surely suggest something more extensive down the road.

Bankers have long enjoyed more political clout than most private business executives in this country, but that may be ending with today`s wave of bailouts. Taxpayers are going to resist the ultimate ante-up, and that goes for trying to pass the responsibilities of Third World debt on to them.

With this bailout bill, there should be fundamental banking reform, so that free banking will not be threatened.